What’s a Portfolio?
by Robert Capanna
Merriam Webster defines a portfolio as “the securities held by an investor”. That, in fact, is how most investors think about their portfolios: the collection of securities that they own. But at PMA we think of a portfolio as an intentionally constructed collection of securities designed to behave within risk and return constraints that meet the investor’s goals. While that might seem to be a small distinction, it is actually based on a very robust set of ideas about how and why to construct such a portfolio.
In the first case, the portfolio results from individual investments in stocks, bonds and maybe mutual funds or ETFs. Presumably, the investor chooses these particular investments because he finds them compelling. He might even have some overall criteria for security selection that guides his choices, but those choices are largely centered around “how good” a particular investment seems to be. The investor has the added comfort that if one of those investments doesn’t work out – fails to deliver the expected return or even loses its principal value – the other investments that he owns might balance out the loss with gains. He might even tell himself that his portfolio is “diversified” because he owns more than one security.
The essential difference in these two approaches is that in the first case, the portfolio is what the investor ends up with after selecting securities that appeal to him. In PMA’s thinking, by contrast, securities are selected based on the role they will play in the portfolio. In the first, the individual investments are the primary focus. In the second, the behavior of the entire portfolio, not the individual securities, is what matters. Let’s explore some of the big ideas behind this seemingly small distinction.